Home Equity Loan to Pay Off Credit Cards
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Using a home equity loan to pay off credit card debt can be a smart move, but it’s not without risk. Since credit card debt usually has a much higher interest rate than mortgage debt, you could save money and get out of debt faster with this strategy.
The big risk is that if you can’t repay the home equity loan, you could lose your home. Not repaying your credit card debt can also have serious consequences, but you’re less likely to lose your home.
Here’s what you need to know about paying off your credit card debt with a home equity loan:
How to use a home equity loan to pay off credit card debt
To pay off credit card debt with a home equity loan, you’ll first need to qualify for a home equity loan. Home equity is the part of your home’s value that you don’t owe to the bank. For example, if your home is worth $350,000 and you owe $250,000 on your first mortgage, your equity is $100,000, or about 28.5%.
A home equity loan, also called a second mortgage, will let you access a portion of that $100,000 as a lump sum. You can use the money however you want and take up to 30 years to repay it.
The long repayment period and fixed, lower interest rate can immediately reduce your financial stress. And if you avoid taking on new credit card debt, your home equity loan can help you make steady progress toward getting out of debt for good.
Home equity loan limits
On average, the most you can usually borrow between your first and second mortgages is 80% of your home’s value. This percentage is called your combined loan to value ratio, or CLTV.
Some lenders have stricter loan requirements and limit borrowing to 70% of your CLTV, while others have looser requirements and may let you borrow up to 90%. Your financial profile will also affect how much you can borrow.
Here’s how to calculate your home equity:
Home value － Mortgage principal balance = Home equitySo, let’s assume again that your home value is $350,000, your mortgage principal balance is $250,000, and your home equity is $100,000. With a $250,000 mortgage balance, you’re already borrowing against 71.5% of your home’s value. The strictest lenders that limit CLTV to 70% wouldn’t approve your home equity loan application.
Others might let you take out a home equity loan (or a home equity line of credit) for anywhere from $30,000 (80% CLTV) to $65,000 (90% CLTV).
Along with having enough equity, you’ll also need to meet these qualifications:
Benefits of using a home equity loan to pay off credit card debt
Using a home equity loan to pay off credit card debt can have several benefits:
- They offer lower interest rates than credit cards. The typical credit card interest rate for someone carrying a balance is approximately 17%, according to the Federal Reserve. But home equity loan interest rates can run as low as 3% for highly qualified borrowers.
- They have a long repayment period. A home equity loan’s term can be as long as 30 years.
- You’ll enjoy lower monthly payments. A lower interest rate plus more time to repay your loan can improve your cash flow.
- You can borrow more money. Depending on how much home equity you have, you may be able to borrow more with a home equity loan than with other options, like a personal loan.
- They have fixed rates. The unpredictability of a variable APR on a credit card can make it harder to pay off debt. A home equity loan will lock in your interest rate for the entire repayment period.
You can also pay off other debts with a home equity loan.
Drawbacks to using a home equity loan to pay off credit card debt
Using a home equity loan to pay off credit card debt has its drawbacks too:
- It won’t save you from bad habits. If you haven’t learned new money management skills to replace the habits that got you into debt, using a home equity loan to pay it off will only be a temporary fix. (Of course, bad habits aren’t the only reason people get into credit card debt: illness, unemployment, and emergencies can also be the cause.)
- Your home will serve as collateral. A home equity loan is secured by your house, so if you default on the loan, there’s a chance it can be foreclosed on. Credit cards don’t have collateral. That said, if you default on your credit card bills, a debt collector could obtain a judgment against you and force the sale of your home, depending on your state’s laws and how much equity you have.
- It might be harder to sell. The more you owe on your home, the greater your risk of owing more than your home is worth if the market declines. This situation is called being underwater. If you’re underwater and want to sell your home, you’ll have to tap into your savings to pay off your mortgage.
- You might pay more interest in the long run. Despite getting a substantially lower interest rate on a home equity loan, if you take a lot longer to pay it off than you would have taken to pay off your credit card, you might not achieve the savings you expected.
- You might pay closing costs. Any closing costs you have to pay will reduce your savings from refinancing your credit card debt. Some lenders don’t charge closing costs on home equity loans, but they might bundle these costs into a higher interest rate.
How to pay off credit card debt without a home equity loan
Before you take out a home equity loan to pay off your credit card debt, research these alternatives so you can choose the best option for your situation:
- Personal loan: A personal loan allows you to borrow money based on your income and credit score. A personal loan is usually unsecured debt, which doesn’t directly put your assets at risk.
- Debt consolidation loan: A debt consolidation loan is just a personal loan that’s marketed as a way to pay off multiple debts.
- Balance transfer credit card: Many credit cards offer a low introductory interest rate on balance transfers. If you have excellent credit, the rate can be as low as 0%. However, you’ll also pay a balance transfer fee of the amount transferred, usually 3%. If you miss any payments or don’t pay off your balance before the introductory rate expires, this strategy can become costly.
- Cash-out refinance: A cash-out refinance replaces your first mortgage with a new, larger mortgage and deposits the difference in your bank account. This loan may be a good choice if interest rates have dropped since you took out your mortgage. However, you’ll have to balance the potential savings against the closing costs of a cash-out refinance and the risk of using your home as collateral.
- 401(k) loan: If your plan allows it, you may be able to borrow against your 401(k) to pay off credit card debt. You’ll repay the loan to your own account with interest. But you might have to pay early withdrawal penalties if you don’t repay the loan, and you risk falling behind on saving for retirement.
- Credit counselor: A credit counselor can offer personalized guidance and accountability to help you pay off your balances. Just be sure they are reputable — there are plenty of debt relief and credit repair scams that consumers regularly fall prey to.
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How to pay off credit card debt without a loan
You also have options for paying off your credit card debt without taking out a loan of any kind:
- Trim unnecessary spending. If paying off credit card debt is a priority, you’ll have to deprioritize something else. Cut any unnecessary expenses from your budget, like streaming subscriptions or cable.
- Rent out part of your home. A drastic move that slashes a large expense — like renting out your basement or another room in your home — might also be an option if you’ve already slashed your discretionary spending.
- Seek a raise. The best raises often come from changing employers and negotiating a better salary and benefits package. If you’re up for it, this path could get you out of debt faster or with fewer spending cuts.
- Create a spending plan. Before you get your next paycheck, allocate every dollar to a specific purpose.
- Try a debt repayment strategy. If you have more than one credit card to pay off, strategies such as the snowball method or avalanche method could help you build momentum toward getting out of debt.
- Pay more than the minimum. Maybe you can only pay $5 over the minimum, or maybe you can pay double. Just keep moving forward and don’t add new charges to your card.
- Automate your payments. If your cash flow is consistent, automated payments can help you avoid late fees and penalty rates. If you don’t have automatic payments turned on or prefer not to have them, set up multiple calendar reminders.
Is a home equity loan to pay off credit cards right for you?
If you’re not confident you’ll be able to repay your home equity loan, or if you think you might sell your home soon, you could end up worse off by tying more debt to your home. It may be worth giving the no-loan strategies above a chance before going the home equity loan route.
If the circumstances that created your credit card debt are behind you and your income will easily support your home equity loan payments, getting the loan could save you money and strengthen your finances — and provide you with peace of mind.
Keep Reading: Home Equity Loan vs. Home Equity Line of Credit (HELOC)